From shareholder value to CEO power: The paradox of the 1990s

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From shareholder value to CEO power: The paradox ofthe 1990sRobert Boyer

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WORKING PAPER N° 2005 - 10

From Shareholder Value to CEO Power: The Paradox of the 1990s

Robert Boyer

Codes JEL : D21, D23, G32, G34

Mots clés : Managers’ control and remuneration, stock-options, history of quoted corporations, optimal contract theory, economic and political power of managers, internet bubble

CENTRE NATIONAL DE LA RECHERCHE SCIENTIFIQUE – ÉCOLE DES HAUTES ÉTUDES EN SCIENCES SOCIALES ÉCOLE NATIONALE DES PONTS ET CHAUSSÉES – ÉCOLE NORMALE SUPÉRIEURE

From Shareholder Value to CEO Power: the Paradox of the 1990s♣

Robert BOYER

Abstract

Why did CEOs remuneration exploded during the 90s and persisted to high levels, even after the bursting out of the Internet bubble? This article surveys the alternative explanations that have been given of this paradox mainly by various economic theories with some extension to political science, business administration, social psychology, moral philosophy, network analysis. Basically, it is argued that the diffusion of stock-options and financial market related incentives, that were supposed to discipline managers, have entitled them to convert their intrinsic power into remuneration and wealth, both at the micro and macro levels. This is the outcome of a de facto alliance of executives with financiers, who have thus exploited the long run erosion of wage earners’ bargaining power. The article also discusses the possible reforms that could reduce the probability and the adverse consequences of CEOs and top-managers opportunism: reputation, business ethic, legal sanctions, public auditing of companies, or shift from a shareholder to a stakeholder conception. Introduction a Puzzling Paradox In the era of shareholder value, how should we explain the boom in manager’s, especially CEOs’ remuneration, which persisted even after the bursting of the Internet bubble? This article tries to disentangle alternative explanations of this paradox. It suggests a likely interpretation: the diffusion of stock options and financial market-related incentive mechanisms, that were supposed to discipline managers, has entiled them to express their power, not least in terms of their remuneration and wealth. This is the outcome of a de facto alliance of executives with financiers, who have exploited the long-run erosion of wage earner’s bargaining power.

Why did such acute concern about managers’ remuneration arise at the end of the 1990s and not before? Both corporate-related factors and the macroeconomic context seem to have played a major role in the emergence of the paradox of managers’ compensation (section2). The complexity of the forces that shape the performance of corporations and the incentives that govern managers’ behaviour addresses challenging questions for economic as well as managerial theories of the firm. In a sense, the search for an optimal principal/agent contract is bound to fail precisely because the objectives of the managers and

♣ Extrait de Competition &Change, Vol.9. n°1, March 2005, p. 7-47.

8 R. BOYER

shareholders can never be totally reconciled. This article develops an unconventionalinterpretation of the seminal analysis by Jensen & Meckling (1976). Given the near impossi-bility of convergence towards a first-best pay system for managers, there is some room foran alternative approach, taking into account the existence of a significant managerial powerwithin the modern large corporation (section 3).

The analysis is extended to a political economy approach. During the last half-century the relationships between executives, employees, consumers, finance and the Statehave been transformed. Taking into account the shifting alliance between these stakeholderscasts some light upon the issue under scrutiny: how can we explain the unprecedented boomin executive remuneration, which runs far ahead of corporate performance in terms of valuecreation and shareholders’ wealth? The answer is simple, if not trivial: managers have usedthe pressures of institutional investors and diverted them for their own benefit. This gives expost the impression of a de facto alliance of managers with institutional investors. This shifthas contributed to the process that had already curbed the bargaining power of employees;furthermore the financialization of the wage/labour nexus has imposed/induced labour toaccept a larger share of risk (section 4).

The bulk of the article surveys the empirical evidence from the abundant literatureabout managers’ compensation. Numerous converging statistical analyses confirm therather large autonomy and significant power of managers at the firm level (section 5).Similarly, it is argued that the highly specific social and macroeconomic context of the 1990shas given managers renewed power in the political arena. Even economic policy and thetax system have been redesigned according to this new distribution of power betweencorporations, institutional investors and wage earners (section 6).

A short conclusion summarizes the core arguments and findings. It is argued thathistory does not stop there. Public opinion is infuriated by the persistent rise of some chiefexecutive officers’ (CEO) remuneration in spite of poor corporate performance and sharpstock market decline. This puts two other actors at the forefront: the lawyers and moregenerally the judiciary. Finally, the State, even though basically pro-market and pro-business, is compelled to intervene: the Sarbanes–Oxley legislation, passed in the UnitedStates under the pressure of recurring scandals, probably opens a new epoch for corporategovernance with uncertain long-term consequences.

At the Origin of the Contemporary Concern about Managers’ Remuneration

The history of intellectual representation of the corporation and its various legal con-ceptions in a sense mirrors the actual long-term historical process of transformation ofbusiness. Each of these conceptions tries to capture a specific feature that has been domi-nant at some epoch. Thus the complexity of the issue of controlling and rewarding managerscannot be understood without a brief history of the factors that have shaped the presentposition. For simplicity’s sake, a contemporary query about executive compensation maybe seen as the most recent act in a drama that began more than a century and half ago.

The Crisis of the Previously Successful Managerial CorporationThe first act takes place in the last third of the nineteenth century. In most industrializedcountries, and especially in the United States, family-founded and owned firms encounterlimits in capturing the advantage derived from the new technologies that required more

9FROM SHAREHOLDER VALUE TO CEO POWER

capital and closer links with scientific advances. A wave of mergers makes clear the meritsof the joint-stock corporation as a method of mobilizing dispersed savings. This is so forthe railroad industry and then the chemical industry. The invention of limited liability forshareholders plays a crucial role: individuals can diversify risk by investing in a portfolioof various traded companies. Thus the stock market and the bond market become highlyliquid via the activity of buying and selling shares, quite independently of the irreversibilityof productive capital and the everyday management of the company.

Consequently, there are two sources to the separation of ownership and control. Onone side, family managers are replaced by salaried ones to whom the management of thefirm is delegated. Incidentally, the division of labour that had taken place at the shop-floorlevel is also observed in the management of large companies. In a sense, managers tendto become bureaucrats in charge of taking rational decisions, informed by the advance ofscience, technology and management. On the other hand, individuals, as investors, enjoy thefreedom to optimize the rate of return on their wealth by transacting in more and moredeveloped financial markets in London and New York. By the way, except when scandalserupt, individual investors do not ask for close monitoring of the managers, providedthey deliver a reasonable rate of return. It is the epoch of the triumph of the managerialcorporation ‘à la Berle & Means’: the de facto complementarity between the liquidity ofsaving and the specialization of management delivers an unprecedented dynamic efficiency,and therefore few criticisms are voiced by experts and public opinion on behalf of dis-contented shareholders. The only concern is about the risk of monopolization of productmarkets and concentration of capital, but these are mainly the complaints of the labour andsocialist movements (Figure 1).

But the heyday of the managerial corporation does not survive into the 1970s. Act IIbegins when the previous favourable trends are reversed. The very diffusion of this canoni-cal model to many activities finally triggers adverse trends. First, managers embark onexcessive diversification with no clear synergy with their ‘core competences’, to use the termthat will be proposed during the 1980s to promote the splitting of the large conglomerates.Second, this excessive diversification and the strains associated with the impact of near fullemployment upon labour discipline and work intensity trigger a significant productivityslowdown. Third, the oligopolistic nature of competition in product markets erodes theinnovativeness of the maturing large corporation, at the very moment when newcomersin Europe and Asia challenge the American way of doing business. These strains on themanagerial corporation are correlated at the macro-level with the demise of the post-WorldWar II growth regime: the productivity slowdown generates pressures on costs that areturned into price increases due to a rather accommodating monetary policy (Aglietta 1982).The stage is ready for Act III.

Value Creation and Shareholder Value as Disciplinary DevicesThe first reversal takes place in the conduct of monetary and budgetary policy. Conserva-tive central bankers replace the Keynesian principles with a monetarist credo according towhich inflation has to be curbed in order to move towards monetary and financial stability,at the possible cost of a growth slowdown due to high and unprecedented real interest rates.Since the real interest rate on bonds becomes superior to the dividend/price ratio on stocks,corporations accordingly have to adjust wages, employment and their investment decisions(Lazonick 1992). The bargaining power of wage earners is therefore eroded and this opens anew epoch for the evolution of the distributive shares between wages, profit and the revenue

10 R. BOYER

from finance. Financial liberalization defines the second structural transformation of the1980s and 1990s: new financial instruments are created and diffused, especially in theUnited States and to a minor extent in the United Kingdom. Derivatives and stock optionsare good examples of the success of financial innovations. Consequently, financial instru-ments are more and more diversified and therefore attract new customers in response toan unprecedented specialization of financial institutions and investors. A final shift, in theUnited States, concerns the transformation of pay-as-you-go pension systems into pensionfunds: the large and permanent influx of savings into financial markets improves theirliquidity and depth and simultaneously increases the probability of financial bubbles(Orléan 1999). Furthermore, the concentration of the management of these savings bringsa counter-tendency to the extreme dispersion of ownership: some pension funds may use notonly exit (selling the shares of a badly managed corporation) but also voice (by stipulatingconditions for approval of board decisions).

Fig. 1. Acts I and II: The emergence and the crisis of the managerial corporation.


It is the epoch of value creation, and then shareholder value (Figure 2). In this context,the divergence of the interests of managers and owners emerges as a crucial issue. Why nottry to align the strategy of top managers with the objectives of stock market value maximi-zation on behalf of shareholders? The use of stock options is therefore widely diffused, notonly to the traditional corporation operating in a mature industry but also to start-ups in theinformation and communications technology industry. In the former (traditional) indus-tries, stock options are conceived as an incentive to good management and shift the strategyof CEOs from extreme diversification to concentration on their core business, and econo-mizing on the use of capital. In the latter industries, a large proportion of personnel receivea modest wage but a significant number of stock options that can be cashed if or whenthe expected profits materialize. Incidentally, this reduces production costs and increasesprofits, since US accounting principles in the 1990s did not require stock options to beexpensed in the income statement. The search for radical innovations and stock options as aform of remuneration are closely associated in the vision of the ‘new economy’.

Stock options are therefore central to American business in the 1990s: they are sup-posed to control the managers of mature corporations and reward the professionals andmanagers of the sunrise sectors. Act III seemed to promise a happy ending, but such was notthe case.

Financial Bubble and Infectious Greed: Executive Compensation under ScrutinyIn fact the very optimistic views about higher and higher rates of return on equities drove theboom of the mid-1990s in American stock markets. What was supposed to be a rationalmethod of generating value and wealth has become ‘a casino economy’ whereby everybodytries to get rich as quickly as possible, with little concern for the long-run viability of theirstrategy. The implicit rate of return of most of the start-ups of the new economy was implau-sible but nevertheless attracted investment from well established investment banks andinstitutions. The public were convinced by the financial and popular press that the boom in

Fig. 2. Act III: disciplining the managers by shareholder value.

12 R. BOYER

the stock markets was not a bubble but evidence of an unprecedented area for investmentfeaturing totally new economic regularities. This was an illusion, since the divorce betweenthe actual and the expected rate of return was bound to be recognized and hence reduced, ifnot by a progressive reappraisal, then by a brusque downturn in the financial markets. Thistook place in March 2001, when the Internet bubble burst, generating an impressive series ofbankruptcies: in a sense, the trajectory of Enron is typical of these new relations betweencorporate governance and financial markets (Figure 3).

In this context, the divorce between the supposedly rational goals of incentive payand the effective use of financial, performance-related compensation is made clear by themultiplication of financial scandals and some spectacular bankruptcies. In retrospect, thesurge of stock options appears as a method of fast wealth accumulation by top executivesrather than a method of rewarding the quality of their management. The previous methodsof controlling and rewarding managers are therefore under public scrutiny. Should thiscome as a surprise to the proponents of the indexation of top managers’ compensation toshareholder value?

A Major Challenge to Economic Theory

Actually this issue is not so new. Since Berle & Means, economists have deployed twocontrasting strategies. The first takes into account the transformation of the joint-stockcorporation and finally adopts the stakeholder conception, with no primacy of shareholders’interests. A second considers that the discrepancy between the optimal profit-maximizingstrategy and the actual strategies of managers should as far as possible be removed, in orderto restore the primacy of shareholders. In periods of patient capital and a leading role forthe banks in financial intermediation the first conception may prosper. When finance isliberalized, many new financial instruments are created and diffused around the world, andwhen professional investors manage a large proportion of savings – especially pension funds– the issue of control and reward of CEOs became central and triggered a boom in academicresearch (Murphy 1999).

Back to Michael Jensen and William Meckling’s Seminal ArticleWithin the patrimonial conception of the joint-stock corporation the problem is simple: thetop executives are the agents of the shareholders, since they are hired by them in order todefend and promote their interests, namely their income and wealth. Generally speaking,principal/agent relations were already being used in the Roman empire within the ruraleconomy, but the innovation of the manager/shareholder principal/agent relation is tomobilize specific economic incentives. What type of contract, including pay systems,dismissal conditions and fringe benefits, would realign the objectives of the CEOs with theinterests of shareholders?

The literature offers a hint: in order to limit the distortion of CEO decisions in sucha way as to benefit the CEO but reduce the value of the firm, a proportion of the capitalshould be given to the CEO in order to fill the gap between the patrimonial firm run bythe owner and a joint-stock corporation under the supervision of a manager (Jensen &Meckling 1976: 221). This result has frequently been interpreted somewhat optimistically:adequate incentive mechanisms (profit sharing, stock options, linking CEO compensationto a performance index) could overcome the discrepancy between a first-best solution


Fig. 3. How an alleged virtuous circle turns into a vicious spiral: the Enron story.

and organization, i.e. profit maximization, and the actual decisions of managers that maydistort the strategy of the firm in favour of their own interests.

A closer look at the argument shows that the cost of agency cannot be reduced to zero,because the manager has to be compensated at the expense of shareholders, unless they aregiven all the capital and thus become an entrepreneur without shareholders. From a purelytheoretical point of view, the dichotomy between management and ownership cannot be

14 R. BOYER

overcome. Whatever the pure economic and financial incentive mechanism, there is a cost ofagency associated with the joint-stock corporation. A second wave of the literature has pro-gressively recognized the limits of these incentives. For instance, Michael Jensen and KevinMurphy (1990) are surprised by the low sensitivity of CEO compensation with respect toshareholder wealth (approximately $3 for each $1,000 change in stock market value). Theyhypothesize that public and private political forces explain this departure from what theorywould suggest. This probably explains why other mechanisms have been proposed: thestrength of a corporate culture may reduce the opportunism of the executives, or a form ofbusiness ethic may play the same role. But this overestimates the degree of conformity tosocial norms and their effectiveness, at odds with the principle of individualism that is atthe centre of modern societies. This is the reason why alternative methods of dealing withthe agency problem have been proposed and, indeed, implemented.

A Whole Spectrum of Incentives and ConstraintsMany CEO pay systems coexist and deliver different outcomes in terms of free cash flow,investment, diversification, risk, innovation policy and the choice between internal growthand expansion via merger and acquisition. A priori, a compensation scheme could betailored to any precise objective articulated by the board that would transmit the will ofshareholders (and other stakeholders if they are represented). Within the conventionalpatrimonial conception of the corporation, many devices have been proposed in order tocontrol and reward managers (Table 1).

The value of the stock of the corporation is only one possible reference index, since abonus payment can be indexed to profits, measured according to various definitions. Iffinancial markets are imperfect, inefficient, and if stochastic shocks affect the firm’s resultsand its stock market value, then profit-related pay systems and stock options are far fromequivalent. Furthermore, stock options are different from the attribution of stock to themanagers. A basic divergence relates to accounting rules: until recently, stock options werenot taken into account as costs, whereas a profit-sharing mechanism would explicitly affectthe financial situation of the corporation. The various components of CEO compensation –wage, bonus, stock options, fees for sitting on boards, special credit terms, severancepayment, contribution to retirement – do not attract the same rate of tax. Thus, indirectly,government may indirectly influence the form of CEO compensation.

Incentive pay is not the only mechanism: shareholders’ access to information aboutCEO remuneration may trigger their demands for control of those payments, on top of theactivities of any remuneration committee. Simple transparency may have a disciplinary rolewhen CEO compensation explodes at a time when their corporation is near bankruptcy.But such a mechanism can affect only major discrepancies between executive compensationand the firm’s performance, it does not deliver the fine tuning that would be required forgood governance on an everyday basis. Another avenue explores the role of the indepen-dence of the members of the remuneration committee: a priori, at each period they couldadjust managers’ compensation to actual achievement. The issue is the choice betweenan automatic rule and pure discretion.

But, for most economists, only competition can govern this complex process. If CEOsdivert too many resources from an efficient allocation the undervaluation of the firm onthe stock market will trigger a hostile take-over. In order to prevent such a take-over, the


board should ex ante limit the opportunistic behaviour of top managers. The last-resortthreat is, of course, bankruptcy. Back in the 1960s and 1970s large corporations were sup-posed to be ‘too big to fail’ but such is no longer the case. But, if bankruptcy is the last-resortdeterrent against excessive CEO remuneration and bad managers, there is a more commonmechanism, i.e. the creation of a market for corporate governance. Actually, the firing ofCEOs has become more frequent and the duration of employment of CEOs has beenreduced, especially in the United States. For instance, the period of notice for executive

TABLE 1

How efficient are the various methods of controlling managers?

Device Rationale Limits

Incentive payIndexing wage on Aligning managers’ and Possible manipulation ofperformance rank-and-file workers’ interests performance by managers

Bonus linked to profit Aligning managers’ interestsand firm strategy

Stock options Aligning CEO interest with Still a major gap between CEOshareholders’ wealth and shareholders’ interests

Attribution of stock Aligning CEO interest with Loosely correlated with CEOof the company shareholders’ wealth strategy and large benefits

during financial bubble

TransparencyPublic disclosure of Trigger outrage from Camouflage tactic by managersCEO’s remuneration shareholders and institutional in spite of statements in favour

investors of transparency

Remuneration settingCreation of an independent Prevent self-determination The CEO may largely controlremuneration committee of remuneration by CEOs the committee

Large number of independent Prevent excessive remuneration The income of members maymembers of the board to the detriment of shareholders depend on their generosity to

the manager.

Survey by consultant firms of Set an objective benchmark The reference to average orCEO remuneration. median remuneration induces

spill-over and excessive payincreases

Market for corporate governanceFiring of CEOs Incentive to commitment Exceptional configuration in

the past

Threat of take-over Puts a limit on CEO Golden parachute for losersopportunism CEO income may increase even

if shareholders suffer valuedestruction

Source: Inspired by Bebchuk & Fried (2003).

16 R. BOYER

directors was drastically reduced between 1994 and 2001 (PIRC 2003: 8). This is an interest-ing development, since it could work as a Smithian solution to CEO remuneration: thecreation of a fully fledged market for managers could provide an objective basis for deter-mining their value. But this is to assume that complete recognition and assessment of thequality of managers is possible, and it is not at all evident, given the idiosyncratic natureof managerial talents. After all, the net profit of a corporation is the outcome of the mixof complementary and specific assets, including executive talents (Biondi et al. 2004).Therefore, generally speaking, the market is unable to fix a price for managers.

Clearly, all these devices are far from implementing shareholder value, since they are allconstrained (see Table 1, column 3). Managers can manipulate the index of performance,not least by means of dubious if not illegal accounting practices. During financial bubblesthe tide of speculation enriches those CEOs who benefit from stock options but only a smallfraction of the extra compensation is related to the quality of their management. Even whenthe bubble burst, it is quite surprising to note, some CEOs renegotiated their stock optionsin order to maintain their total remuneration. In 2001 the value of stock options granted tothe CEOs of S&P companies, America’s largest, rose by 43.6 per cent in a year when thetotal return of those companies fell by almost 12 per cent (Economist 2003). Similarly, in2002 the median pay of the 365 CEOs covered by Business Week increased by 5.9 per centbut the total returns of the S&P 500 companies were down by 22 per cent (Johnson 2003).

Transparency is quite difficult to achieve, since part of the profitability of corporationsderives from proprietary information, knowledge and technology. The public disclosure ofCEO remuneration may trigger outrage from shareholders and institutional investors, butthe more complex and diverse the compensation mechanisms the more easily managers canadapt their tactics and adopt camouflage. Similarly, independent directors and members ofthe board and remuneration committee are a priori desirable but do not necessarily over-come the large asymmetry of information and power between CEOs and those directors.Another mechanism may hinder the efficiency of remuneration committee: the directorsand CEOs may belong to the same web of boards, so forming a network of mutual exchangeof high remuneration (Economist 2003). Furthermore, the reference to the current remu-neration of CEOs via surveys undertaken by remuneration consultants may have perverseeffects: the reference to average or median remuneration generally triggers a spill-over ofexcessive increases. Last but not least, the frequent negotiation of golden parachutes evenfor the least successful CEOs drastically reduces the incentive for managers to be efficientand fulfil shareholder value and wealth creation.

From Optimal Contracting to a Managerial Power ApproachBoth the historical retrospective study of US corporations and the conclusions derivedfrom transaction costs and principal/agent theory confirm that it is quite difficult to monitorexecutives in order to comply with the objective of profit maximization or shareholder valuepromotion. Therefore it is not surprising to observe during the 2000s a disparity betweenstill booming executive compensation and poor stock market performance. This suggeststhat the normative theory of CEO compensation should be completed by another approach.One of the best candidate stresses entrenched managerial power (Bebchuk & Fried 2003) andit enlightens the apparent paradox that optimal contracting recurrently faces.

Here the diagnosis is quite different (Table 2). For optimal contracting, the opportunis-tic behaviour of managers should be controlled by the strengthening of competition onproduct, labour and corporate governance markets. More precisely, the recognition of


value creation and shareholder value should be imposed on managers as a core if not aunique incentive mechanism. The managerial power theory develops a more Machiavellianvision: in order to minimize the outrage of shareholder and public opinion, managers adoptcamouflage strategies. Similarly, the enthusiasm of investors for equity-based compensationis adopted and used by CEOs who thereby find a justification for large increases in theirincomes. Whereas in the 1960s and 1970s executive wages were defined as a multiple ofmedian workers’ income, during the 1990s the larger part of their income was related to theflow of profit or the appreciation of their shares. Hence a device that was supposed to disci-pline managers has actually been distorted in order to extend their wealth to unprecedentedlevels (see Figure 10).

Any reference to market benchmarking for CEO compensation may have the effect notof disciplining the remuneration committee but of triggering spill-over and escalation,whereby less well paid managers ask for median or average pay, which in turn raises averagepay and thus initiates a vicious circle. Similarly, the shift from indexation of pay related toprofit or cash flows to stock options is not without risk. First, the stock market valuationtakes into account the macroeconomic situation, the level of short-term interest rate andsectoral effects, and does not exclusively gauge the contribution of the managers to the pros-perity of the joint-stock corporation. Furthermore, there are a lot of stochastic elements andmimetism in the valuation of a firm. It is therefore risky not to filter stock market value by

TABLE 2

Two approaches to the control of managers

Optimal contracting Managerial power

Diagnosis1 Opportunistic behaviour of managers Minimize outrage, via camouflage

2 Market for capital, labour and corporate Enthusiasm about equity-based compensationcontrol are not sufficient benefits to managers’a

Solution3 Design incentive pay systems. Managers’ Compensation consultants justify executive

behaviour optimizes value creation pay CEOs control the board in charge of theirand/or shareholder wealth remuneration

Adverse effects4 Managers reap windfall income via stock Option plans that filter out windfalls are not in

price increase independent of their actions the interests of managers. Therefore they arenot usedb

5 The threat of take-over should discipline Mergers and acquisitions justify higherCEOs compensation of managers but do not always

increase shareholder value

Notes:a 2000: CEO compensation was an average 7.89% of corporate profits in firms making up the 1500

company exe comp data set (Balsam 2002).b 2001: 5% of 250 largest US public firms used some form of reduced windfall options (Levinston

2001).Source: Inspired by Bebchuk & Fried (2003).

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these macro and sectoral determinants. Second, and still more important, the net profit ofany firm does not result from the optimal mix of substitutable standardized factors valuedon the market. Almost by definition, higher than average profit rates derive from thecomplementarity of firm-specific assets: among these, the talents of the manager cannotbe measured by a typical competitive market. Third, today’s decisions of top executives leadto tomorrow’s investments and the products/profits of the day after tomorrow. Stockoptions that can be used over a short period of time cannot capture the necessary long-termorientation of an efficient pay system.

This confirms the merit of the managerial power approach in explaining these featuresthat are at odds with the predictions of optimal contracting. Option plans that filter outwindfalls are not in the interest of CEOs. Mergers and acquisitions frequently destroy valueinstead of creating it, but the executives nearly always increase their compensation alongwith the size of the corporation. More fundamentally, CEOs by definition have accessto insider information1 and they are generally better informed of the specific sources ofcompetitiveness in their firm than financial analysts working outside the firm. Even the mosthighly specialized analysts, who are experts in crunching financial data and gleaning ad hocinformation during roadshows, are rarely able to capture the intrinsic assets and liabilitiesof a firm.

Controlling and rewarding Managers: an Issue of Political Economy

If the managerial joint-stock corporation is not more efficient and does not increase its sharevia the selective mechanisms of competition – both in product and financial markets – howshould we explain the boom in CEO remuneration during the 1990s? Nearly all countries areaffected, and the trend persists in spite of suspicion from minority shareholders and inthe face of hostile public opinion. For instance, in France one still observes diverging trendsof CEO remuneration and financial results for a significant number of corporations (seeappendix). This article proposes a twofold explanation.

1 First, history suggests that managers have always been part of the leading alliance,reaching an accommodation successively with various groups. The novelty of thepresent period is an alliance with finance, at odds with the Golden Age of Fordism, whena compromise was struck with wage earners.

2 Second, there is a more theoretical and structural reason for this hegemonic role ofmanagers. Where does the profit of any firm come from? Basically, from the idiosyn-cratic mix of firm-specific assets, and it is precisely the role of managers to organize therelated complementarity such that they have significant autonomy in deploying theirstrategies and still more in informing outsiders about the financial situation of the firm.

Managers are the Centre of Shifting Alliances, most recently with FinanciersThe current bargaining position of executives is the outcome of a series of long-runtransformations in the relations between wage earners, consumers, financial markets,the international economy and the nation State. Three quite distinct periods can bedistinguished.

The 1960s: an alliance between wage earners and managers in the Fordist growth regime.This period has already been mentioned by the brief history of the concept and the forces


that shape the modern corporation. Actually the 1960s experienced a quite atypical accom-modation between wage earners and managers. Given the strong bargaining power of tradeunions, the pro-labour orientation of many governments and the high control over financevia a series of national regulations, a Sloanist corporation was built upon three premises.First, workers accept modern production methods and productivity increases in exchangefor indexation of real wages to productivity (Aglietta 1982; Boyer & Juillard 2002). Thiscreates a large market for mass production and sustains the multidivisional and largeconglomerates (Boyer & Freyssenet 2002). Second, professional managers see themselvesas wage earners and express their income as a multiple of the average wage. Third, financialmarkets are not in a position to exert a strong influence on the strategic choices of corpora-tions. This de facto alliance of managers with wage earners triggers an unprecedentedgrowth regime. Its economic benefits easily sustain the related social compromise (Figure 4).Paradoxically, this period was perceived by contemporary analysts as highly prone toconflict between labour and capital, whereas in retrospect the demand for higher wages andbetter welfare were highly functional for the growth regime.

The 1980s: internationalization erodes the old alliance. But such a regime was notto last for ever: its very success triggered adverse trends such as accelerating inflation,rising unemployment and more basically a degree of internationalization that progressivelyeroded the alliance between managers and wage earners. Whereas the international regimewas highly permissive in the 1960s, recurring external trade deficits put the question ofcompetitiveness of firms at the centre of the political and economic agenda. Corporationshad to restructure their organization and frequently slim down their work force, and thiswas quite a drastic reversal with respect to the previous Fordist compromise. During thisperiod competition in product markets puts consumers at the forefront, who are seen asgaining from external competition via moderation of the prices of imported manufacturedgoods. The competitiveness motive is invoked by managers in order to rewrite labour con-tracts and internationalization becomes the main preoccupation of governments. In a sense,the sovereignty of consumers plays the role of an enforcement mechanism in order todiscipline workers, and managers cleverly used this device (Figure 5). Implicitly at least,managers invoked the role of consumer demand in the context of more acute international

Fig. 4. The 1960s. The first configuration of actors: the Fordist compromise.

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competition, in order to impose or negotiate a new configuration of the wage/labour nexus.During this period the adjustments required by a rather turbulent international economyinvolved greater risk sharing by workers via flexibility of hours, the revision of the lawsprotecting employment and, of course, greater flexibility of wages and the slimming down ofwelfare.

The 1990s: under the rubric of shareholder value, a hidden alliance of managers withfinanciers. The internationalization of production has not been the only feature of the lasttwo decades. Since the mid-1980s financial liberalization, the multiplicity of financial inno-vations and their diffusion from the United States to the rest of the world have drasticallychanged the conception of corporate governance as well as the conduct of economic policy.The conventional view is that joint-stock corporations in the manufacturing and servicesectors have been submitted to the strong requirements of institutional investors. The powerof these new players precisely derives from financial deregulation, and the high mobility ofcapital entitles them to demand changes in the rules of the game: higher rates of return oninvested capital, profits that meet forecasts and financial analysts’ expectations, and asteady flow of profits generated by the corporations. In the United States, and to a lesserextent in the United Kingdom, a finance-led growth regime has replaced the Fordist one,but the relevance of this model was not warranted in countries such as Germany or Japan(Boyer 2000). In spite of this divergence in national growth regimes, the ideal of shareholdervalue, or at least its rhetoric, has been diffused all over the globe.

Nevertheless, closer investigation suggests a more nuanced appraisal. Given the fadpromoted by financial investors around the promotion of stock options, and the support ofmany experts in corporate finance, the objective of realigning the interests of shareholdersand managers has been widely diffused, first in the United States, then in many other OECDcountries. Cleverly, without necessarily admitting it openly, managers have used thedemands of institutional investors to redesign their own compensation. On top of theirsalary, many forms of remuneration related to profit and stock market valuation havetherefore been evolving, and they have drastically increased the total income of CEOs(see Figure 11). Top executives have been practising the art of judoka: converting the

Fig. 5. The 1980s. The second configuration of actors: an international competition-led regime.


pressure of the financial community into a counter-move that benefits them and continuesto erode the bargaining power of wage earners.

Thus, beneath the tyranny of investors, an implicit alliance between managers andinvestors takes place, and wage earners have to submit to a new wave of labour marketderegulation (Figure 6). For instance, they have to bear a greater share of risk, so as tostabilize corporate rates of return, and to avoid the elimination of their jobs. The wage/labour nexus itself is transformed accordingly. First of all, the shift from pay-as-you-gopension schemes to pension funds generates a huge inflow of savings into the stock market(Montagne 2003), and this propels a finance-led growth regime in the United States.Second, in order to try to compensate for very modest wage increases, permanent workersaccept various forms of profit sharing, and even gain access to shares in their companyvia special schemes. Managers have been reorienting their alliances, and this has definiteconsequences for macroeconomic patterns, régulation modes, income inequality and eveneconomic policy formation.

The Power and Informational Asymmetry in Favour of ExecutivesHow can we explain this pivotal role of managers? A political economy approach suggestsone interpretation: given their position in the firm, structurally managers are able to exertpower within the economic sphere. Power relations are not limited to the political sphere:they exist in other guises in the economy (Lordon 2002). Many factors may explain a clearasymmetry both with respect to labour and to finance:

1 First, a mundane observation: executives make decisions on an everyday basis anddirectly affect the strategy of the firm. By contrast, boards exercise control at a lowfrequency, the control exerted by financial analysts is only indirect and in most OECDcountries wage earners have no say in the management of the firm they work for.

2 Therefore managers built up special knowledge and competences that are not revealed tofinancial markets, competitors or representatives of labour. External financial analystsmay gather statistical information about the firm and its competitors, but the realsources of profitability may still be hard to pin down from lack of familiarity with thedetails of particular corporate success and its determinants.

Fig. 6. The 1990s. The third configuration of actors: the alliance of investors and managers.

22 R. BOYER

3 By definition, no insider information should be revealed or divulged to outsiders, since itmight well be the source of extra profits. There is therefore a clear incentive to use suchinformation strategically and opportunistically. Of course, insider trading on the stockmarket is illegal, but the everyday use of insider information and knowledge is not.

4 There is a strong asymmetry of power and information between the top managers and thevarious boards and committees. Members of the latter are appointed by the executives,the information they are given is assembled by the staff of the corporation, and, finally,the members of the board tend to belong to the same social network. Thus the probabil-ity of the agenda and the proposals put forward by the CEO being accepted is quitehigh. Similarly, during the general meeting of shareholders, minorities do not have theresources to put forward alternative nomination and proposals (Bebchuk 2004). There-fore the control of managers by auditors, financial analysts and shareholder organiza-tions is exercised ex post and generally when the situation has become dramatic. Finetuning the control of managers is difficult indeed.

All these arguments derive from the same central feature of profit generation. The patrimo-nial conception of the corporation assumes that profit derives from the mix of substitutableand generic factors of production, according to the prevailing system of prices. The basichypothesis is that each factor is paid according to its marginal productivity. This modelbreaks down as soon as an organic conception is adopted: the corporation is defined by a setof complementary competences that are difficult to replicate. This is the source of the netprofit of the firm (after interest payments). In effect, the entrenched power of executives isthe mirror image of the ability of the firm to generate profits. It is therefore illusory to thinkthat traders on the financial markets can know better than the managers the origin andcauses of the success of a given corporation. Their informational advantage derives fromstatistical analysis of the macro and sectoral determinants of a sample of firms belonging tothe same sector.

When the Financial Crises and Scandals erupt, two new Players: the Lawyer and the ActivistThe bursting of the Internet bubble in the United States and the financial scandals thataffected the United States and many other OECD countries again shifted the previousalliances. Paradoxically, the instability of the finance-led growth regime could have beenpredicted, and the history of financial crises reveals that the situation in the 2000s is nottotally new. Two new actors then enter into the plot.

Whatever the conflict of interest, the lawyers always win. Given the role of lawyers andthe judiciary in the United States, it is no surprise to observe that the excess of greed of somemanagers has entailed the multiplication of lawsuits whereby disappointed shareholders orwage earners made redundant demand compensation from top executives. But, since theresponsibility for problems is shared among a whole spectrum of professionals (institutionalinvestors, financial analysts, auditors, rating agencies and fund managers and, of course,corporate managers), this is a wonderful opportunity for lawyers to extract a quasi-secureincome: whoever wins the case, lawyers benefit from a positive and substantial fee! Thekey role of these players probably means the disruption of the previous alliance betweenmanagers and financiers (Figure 7).

Public concern about financial regulation: domestic and international activists. Two finalactors have to be brought into the picture. First, households that have lost a significant partof their capital do complain and may sue joint-stock corporations, pension funds, financial


analysts and institutional investors. Second, activists make their voices heard demandingreform of the law on the responsibility of managers and financial intermediaries. Bothdomestic and international activists focus their criticisms and demands for reform onfinance: the latter complain about the social cost of globalization, including financialglobalization (Figure 8). The only way of converting these voices into action is by pressingthe State to pass laws to try and curb the power of corporations and institutional investors.This is essentially a matter of domestic policy. Where the financial scandals have beenmost acute, new Bills have been passed, such as the Sarbanes–Oxley Act in the UnitedStates.

The Power of Managers at the Firm Level: Much converging Empirical Evidence

In many of the previous configurations, top managers have a pivotal role, since they developalliances with other social groups and these alliances vary according to the institutional,political and economic context. The previous hypothesis about the intrinsic power of

Fig. 7. The 2000s in the US. The fourth configuration of actors: the lawyer wins, whatever thesituation.

24 R. BOYER

managers, at both the micro and the macro level, is difficult to test fully and directly, butmuch scattered evidence suggests the existence and permanence of such a power.

Insider Trading: a Manifest Use of Strategic InformationTop managers and members of the board of directors of publicly traded corporationspossess more information about their company than the individual shareholder or evenprofessional analysts. Given this asymmetry, insider trading conveys some informationto outsiders, and this may contribute to the efficiency of the stock market. Generally theliterature finds that stock prices increase after publicly announced grants of stock options toexecutives (Yermack 1997). Two opposing interpretations might be given to this phenom-enon. Either the incentive mechanisms of stock options trigger better management that isafterwards translated into more profits and higher stock market prices. Or executives timetheir option grants in anticipation of news which may be likely to boost stock prices.

A recent study of UK listed companies (Fidrmuc et al. 2003) does confirm that marketreaction to the announcement of directors’ purchases is positive and, conversely, that theannouncement of directors’ sales induces a decline in the stock market. The mere observa-tion of the sequence of announcements and returns suggests that the second hypothesis islikely. In fact, insider purchases are associated with a prior decline in the rate of return and,conversely, insider sales are observed after a period of abnormal positive returns. This couldbe a sign of strategic behaviour by managers and directors.

Fig. 8. The 2000s. The fifth configuration of actors: the threat of State intervention in order todiscipline global finance.


The Diffusion of Stock Option Plans: a Response to Shareholder ValueIf, in theory, stock options are supposed to discipline managers according to the interestsof shareholders, the idea cannot be excluded that managers use this pressure in order toincrease their total compensation. Such a hypothesis comes out from a comparison of CEOpay in the United States and the United Kingdom (Conyon & Murphy 2000).

First, the timing of the diffusion of stock option plans is quite different in the twocountries. In the United States the top executives of the S&P 500 have regularly benefitedfrom stock option plans since the 1980s and they experienced a new increase in thisfrequency during the 1990s. What was new in the 1990s was the diffusion to small andmedium-capitalization firms of this type of remuneration for executives (Figure 9). In theUnited Kingdom the pattern of diffusion is U-shaped, with stock options almost non-existent in the early 1980s, followed by widespread diffusion until they reach a plateau,followed by decline since 1993. These contrasting trajectories could sustain the hypothesisthat the unequal maturation of financial markets, including the diffusion of pension funds,may explain the differences observed in the structure of the remuneration of top executivesin both countries.

Actually, the structure of CEO compensation is quite different in each country. In theUnited Kingdom, base salary is the largest element of total compensation, annual bonus is asecondary source of remuneration, whereas option grants represent only 10 per cent of totalCEO compensation. By contrast, in the United States, base salary is less than a third of CEOcompensation, while stock options represent the largest source of income for top executives(Table 3). Total pay doubles in the United Kingdom only when the size of the firm goes fromless than £200 million to more than £1.5 billion, but in the United States this remunerationis multiplied by more than six times for the same range of size. Lastly, the United States

Fig. 9. The contrasted patterns of stock option diffusion in the US and UK.

Reprinted with permission of Blackwell Publishing, Oxford.

26 R. BOYER

displays an interesting feature: CEO remuneration is far higher in financial services, nearlydouble average remuneration, and option grants in this sector are the major source of totalcompensation. This is further evidence of the financialization of corporate remunerationthat starts in the financial sector and then diffuses to other sectors.

The divergence of CEOs remuneration between the United Kingdom and the UnitedStates is confirmed by the most recent studies that provide data for the early 2000s (Erturket al. 2005). The CEOs of the FTSE 100 receive 74.5 per cent of their compensation byway of basic pay, whereas the share of base salary is only 11.5 per cent for CEOs runningS&P 500 companies. Conversely, cashed options are more than 71.2 per cent of total com-pensation of the largest quoted American companies. These findings are congruent withthe general hypothesis that shareholder value has permeated American corporations moreeasily than British ones. Thus American managers have been able to capture a largerremuneration via the adoption of stock option plans.

TABLE 3

Differing structures of CEO compensation in the UK and the US, 1997

Group Total pay (£000) Average composition of total pay (%)

Sample Average Median Base Annual Option LTIP Otherfirms salary bonus grant shares pay

United KingdomAll companies 510 589 414 59 18 10 9 5By firm sales (£ million)Less than 200 152 452 287 64 17 10 4 5200–500 119 403 335 61 19 8 6 6500–1,500 116 601 507 54 20 10 12 4Above 1,500 123 927 811 55 16 10 15 4

By industryMining/manufacturing 217 564 436 59 17 9 9 5Financial services 84 559 411 60 22 6 7 4Utilities 19 448 382 58 15 6 14 8Other 190 645 397 58 17 11 8 5

United StatesAll companies 1,666 3,565 1,508 29 17 42 4 8By firm sales (£ million)Less than 200 339 1,166 686 38 14 43 1 4200–500 379 1,833 926 36 18 36 3 7500–1,500 458 3,038 1,604 28 18 40 5 9Above 1,500 490 7,056 3,552 20 17 48 5 10

By industryMining/manufacturing 842 3,388 1,540 28 17 43 3 8Financial services 198 6,277 2,787 19 20 47 5 8Utilities 120 1,333 707 43 15 23 6 13Other 506 3,326 1,438 32 16 43 3 6

Source: Conyon and Murphy (2000: 646).


The Larger the Corporation the Less the CEO Pay/Performance SensitivityIf the hypothesis that stock options were designed as an incentive mechanism in orderto control the opportunistic behaviour of those CEOs in charge of the large quotedcorporations, we should observe greater responsiveness of CEOs’ compensation as the sizeof the company increases. Quasi-unanimously the econometric literature finds the oppositeresult. For instance, Conyon & Murphy (2000) find that the pay/performance sensitivityis about 0.07 for small companies but only 0.02 for the largest ones in the United States.Similar results emerge from the British data: pay/performance sensitivity is around 0.05for small companies and decreases relentlessly along with size (only 0.003 for the largestcompanies; Table 4). Of course, this is not necessarily evidence of the immunization of largecorporations’ CEOs from the market’s evaluation of their performance. Rather, the esti-mated coefficient combines the impact of the size and the elasticity of CEO remuneration.

There is more evidence of significant autonomy in the determination of CEO remunera-tion: the mechanism of stock options itself gives them room for manoeuvre. If the optionsare under water, CEOs suffer no downward adjustment of their actual remuneration, sincethe only loss is unseen, thanks to the gap between the actual performance of the company onthe stock market and that which was expected when the stock options were granted.Conversely, exceptional performance by the company is rarely rewarded with an increase ofthe volume of stock options (Stathopoulos et al. 2005).

The Surge in Mergers and Acquisitions: a Benefit for the Managers, less often forShareholdersAdditional evidence of the power of CEOs can be found by considering the merger maniaof the 1990s and previous episodes. On the one hand, most studies find no correlation

TABLE 4

Statistics for stock-based CEO incentives by size

Group Share holdings Share holdings Option holdings Pay/performance(£ million) (% of common) (% of common) sensitivity (%)

Average Median Average Median Average Median Average Median

United KingdomAll companies 7.01 0.46 2.13 0.05 0.24 0.11 2.33 0.25By firm sales (million):

Less than £200 9.86 1.41 4.38 0.63 0.38 0.21 4.72 1.09£200 to £500 9.50 0.70 2.55 0.14 0.24 0.14 2.75 0.42£500 to £1,500 4.55 0.13 0.76 0.02 0.19 0.12 0.91 0.16Above £1,500 3.40 0.33 0.21 0.01 0.10 0.04 0.31 0.05

United StatesAll companies 60.37 3.26 3.10 0.29 1.18 0.72 4.18 1.48By firm sales (million):

Less than £200 16.63 2.07 5.32 0.96 1.84 1.37 6.98 3.65£200 to £500 23.84 2.93 3.94 0.58 1.39 0.94 5.20 2.05£500 to £1,500 32.25 2.64 2.36 0.25 1.12 0.70 3.43 1.26Above £1,500 145.26 4.96 1.61 0.09 0.62 0.40 2.17 0.56

Source: Conyon and Murphy (2000: 655).

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between financial performance and the size of quoted companies (Main et al. 1995). On theother, total CEO remuneration clearly increases with size, especially in the United States(Ertuk et al. 2005). Consequently, although shareholders would be likely to be interestedin a cautious approach to external growth, CEOs usually have a different vision: big isbeautiful, especially for their remuneration. Therefore if the financial markets are highlyliquid, and if a financial bubble distorts the valuation of the company, it is very temptingfor CEOs to use mergers and acquisitions in order to expand their turnover and the capitalthey control.

These conditions were precisely fulfilled in the US stock market during the 1990s: onceagain, a merger mania was rife in spite of the robust evidence that previous episodes havegenerally been quite detrimental to the rate of return of the companies that embarked onmergers and acquisitions (Kaplan 2000). The Internet bubble was no exception: ex post it isclear that the start-ups of the new economy have globally been destroying stock marketvalue, whilst the so-called mature industries have been more profitable than the sunriseindustries. Nevertheless, the compensation of CEOs has rocketed, largely owing to the factthat the speculative wave lifted nearly all stock market prices, regardless of the company.

This is fresh evidence of the implicit alliance between CEOs and top executives, on theone hand, and between investment banks and high-level financiers on the other. The formergroup enjoyed rapid rises in their total remuneration, while the latter group were able togenerate larger and larger profits, by the multiplication of the fees associated with mergerand acquisition operations and active portfolio management, for example on behalf ofpension funds. The average shareholder saw only a fraction of the total financial gains,precisely because operational costs have been increasing with the sophistication of financialmethods. Thus, beneath the shareholder value rhetoric, an implicit alliance between thefinancial industry and top corporate management seems to have been at work during the1990s (Figure 10).

Fig. 10. From the rhetoric to the reality of shareholder value.


Clear Windfall Profits for Managers benefiting from Stock OptionsThe intensive use of stock options in the United States was supposed to align the strategiesof CEOs with the interests of shareholders. It has already been argued that, at the microlevel, such an alignment of interests can never be perfect. New sources of discrepanciesalso emerge when the firm is considered in the macroeconomic context (Figure 11):

1 First, the contemporary financial performance of a firm is largely shaped by thedecisions taken by previous CEOs, given the large time lag between an investment(particularly research and development expenditure) and its impact on the competitive-ness of the firm. Actually the time horizon of financial valuation by stock markets isfar shorter than the time of maturation of innovation and productive investment. The carindustry and even more so the biotech sector are good examples where such time lagsmay cover one or two decades.

2 There is a second source of discrepancy between stock options and the actual merits ofCEOs. During the second half of the 1990s fast and stable growth with little inflationresulted in very low interest rates, thus generating and diffusing a speculative bubble thathad no direct correlation with the quality of management (Boyer 2004). Bad and goodmanagers benefited equally from the common belief that a new growth regime hademerged, and that profitd could only grow and thus sustain unprecedented rates ofreturn on capital invested.

3 A third limit of stock options derives from the fact that financial markets are generallymicro-efficient (i.e. in valuing the relative price of stocks) but macro-inefficient in the

Fig. 11. Why stock options do not sort out the contribution of managers to the performance of thecorporation.

30 R. BOYER

sense that they are not immune to poor intertemporal allocation of capital: overconfi-dence and mimetism are the response to the typical uncertainty of highly liquid financialmarkets, thus generating speculative bubbles (Orléan 1999). During such speculativeperiods the compensation of CEOs bears no clear relation to their contribution to theperformance of the company they run.

These three mechanisms (path dependence and chance, the impact of the macroeconomiccontext and the imperfection of financial markets) totally distort the core virtuous circleenvisaged by the proponents of stock options (Figure 11).

These divergences between the incentive mechanism of stock options at the micro-leveland their macro-determinants have had a major impact in the skyrocketing of CEOremuneration from 1995 to 2000 (Erturk et al. 2005). If financial markets were perfectthe distribution of dividends would be the only relevant performance indicator, as wellas the source of remuneration for shareholders and CEOs benefiting from stock options.In reality, since the early 1980s, the increase in the share price has represented between two-thirds and three-quarters of the total return to shareholders. This is a rough approximationof the overvaluation of CEO compensation during this period.

CEOs have Asymmetrical Power on the Remuneration CommitteeIn large US corporations the compensation level of chief executives is set by a remunerationcommittee. The conventional wisdom states that independent board of directors safeguardsshareholders’ interests and reduces opportunism on the part of management. But neithersocial science theory nor empirical studies confirm this optimistic view (Main et al. 1995).From a theoretical standpoint, CEOs have at least three trump cards compared with themembers of the remuneration committee:

1 The first bias in favour of top management may be termed cognitive: insiders such asCEOs have a better knowledge of the company’s activities, strengths and weaknessesthan outsiders. Furthermore, the executives and financial officers control the informa-tion issued to the various boards as well as to the financial markets. This first asymmetryis obvious when one considers the average time spent by independent directors in con-trolling corporate management as compared with the full-time activity of top executives.

2 Social psychology points out a series of other small-group mechanisms that come intoplay on the board of directors or/and remuneration committee. The principle of reci-procity plays a role in the escalation of remuneration, since the members of the boardand CEOs tend to belong to the same closely knit social group. The respect due to theauthority of the CEO is a second factor that may explain why top executives areoverpaid with respect to an accurate assessment of their contribution to the performanceof the firm. A third mechanism relates to similarity and potential liking for members ofthe same ‘small world’ (Temin 1999).

3 The issue of power introduces a third asymmetry between CEOs and members of thevarious boards. Who nominates whom? If the CEO is nominated before the remunera-tion committee, econometric studies show this has a positive impact upon the level ofthe CEO’s remuneration, particularly when they can nominate economic variables thatcapture the performance of the corporation in a way that is likely to be advantageousin determining pay.


In fact some econometric studies based on Business Week compensation surveys (as far backas 1985) confirm the prevalence of these asymmetries in favour of top executives (Main et al.1995: 317–18). One interesting and one surprising results emerge. On one hand the ability ofthe board to monitor CEO performance and set pay appears greater in owner-controlledfirms. On the other, CEO compensation is higher when the directors are independent! This isthe exact opposite of the prognosis put forward by the advocates of transparent corporategovernance.

After 1997, a Favourite Corporate Strategy: Distorting the Profit StatementsThe relative autonomy of top executives, including CEOs and CFOs, is significant inrelation to the information provided to capital markets. In this respect, the American systempermits significant freedom in the interpretation of the general principles of accounting. Infact, during the Internet bubble, many firms used and abused this opportunity (Himmelberg& Mahoney 2004). In retrospect, the overestimation of corporate profit is so large that theex post accurate figures show a reduction of corporate profit after 1997, whereas ex ante,until July 2001, corporations had persistently announced an ongoing rise in their profits(Figure 12).

Such a discrepancy between real-time private information and ex post publicevaluation in the American national accounts might have many sources. First of all, theaccounting rules are not the same for corporate and national accounts, although this cannotexplain the discrepancy shown in Figure 12, where the Bureau of Economic Analysisestimates have been elaborated using the same set of rules. A second and quite importantsource of discrepancy relates to an unexpected surge in employee stock options exercised

Fig. 12. The systematic overstatements of profits after 1997: as slow process of adjustmentin the US.

Reproduced with permission of the Federal Reserve Board.

32 R. BOYER

during the second half of the 1990s. During this period, stock options were not regardedas a cost by corporations and were thus not expensed in the income statement. This con-tributed to the upward spiralling of stock markets: the shift of employee remunerationfrom basic wage to stock options increases corporate profit, leading to higher valuation ofthe corporation’s shares and, finally, new incentives to award stock options to a broadercategory of personnel. Of course, CEOs and CFOs have been the key beneficiary of thistrend.

From the mid-1990s to the early 2000s two independent surveys show that the share ofstock options exercised in total corporate profit has steadily increased. For the Bureau ofEconomic Analysis they represented 12.4 per cent in 1997 and grew continuously until the2000s, when they represented nearly 39 per cent of corporate profits. According to a surveyby Business Week (2003: 38), option expenses as a percentage of net earnings of S&Pcompanies represented only 2 per cent in 1996, 8 per cent in 2000 and finally 23 per centin 2003 (Table 5).

Nevertheless, a third and more problematic strategy has to be brought into the picturein order to explain the diverging evaluations in Figure 12: quoted corporations have inten-tionally inflated their profit statements, largely using the flexibility of Generally AcceptedAccounting Principles (GAAP), playing the game of creative accounting and in someextreme cases using lies in order to bolster the rise in their share prices (Enron, Worldcom,Ahold). This is the unintended fall-out of the conjunction of shareholder value and the con-vention of a required return on equity (ROE) of 15 per cent. Such a target cannot be reachedon a permanent basis by the majority of firms and sectors, so it is not really surprisingif creative accounting has become one of the favourite disciplines taught in prestigiousbusiness schools and practised by CFOs. During this process CEOs, CFOs and top execu-tives became rich, potentially or actually when they had the opportunity to exercise theirstock options before the stock market nosedived. Again, this is further evidence of thediscretionary power that benefits top management in modern corporations.

TABLE 5

Two evaluations of the impact of stock options on corporate profits in the US

Stock options exercised as a percentage of after corporate profit

1997 1998 1999 2000

Stock options exercised 68.61 100.08 139.29 197.37Profit estimated by Bureau 552.10 470.00 517.20 508.20of Economic analysisStock options exercised 12.40 21.30 26.90 38.80compared with profit

Source: Himmelberg & Mahoney (2004: 10).

Options expenses as a percentage of net earnings for S&P companies

1996 1998 2000 2002

2 5 8 23

Source: The analyst’s accounting observer in Business Week, 20 July 2003, p. 38.


A Last-resort Weapon of CEOs: the Shift from the Transparent to the HiddenCorporate misbehaviour is a recurrent pattern in the history of financial systems. Lawmak-ers then pass new Bills in order to prevent the repetition of financial scandals that aredetrimental to the transparency required in order to foster and sustain the confidence ofsavers in the fairness of financial markets. The Sarbanes–Oxley legislation is no exception,but will it overcome the divergence in the interests of top executives and shareholders?Not necessarily, given the structural power exerted by CEOs at the corporate level. A briefretrospective analysis of the evolution of disclosure rules suggests a cautious approach tothe issue of how managers are rewarded and controlled (Figure 13).

First the salaries of top management had to be made public, then disclosure wasextended to bonuses and more recently to stock options, but none of it has prevented the useand abuse of this quite specific and not very efficient form of remuneration. The financialpress has pointed out that even after implementing quite unsuccessful strategies some CEOshave left their corporations not only with golden parachutes but also with access to specialpersonal credit facilities and, in some instances, special pension provision. Significantly,financial markets were oblivious to such conditions. This means that, even if legislationbrings control over an extended share of CEO remuneration, such executives will still beable to devise new and innovative methods of gaining access to other and hidden (at leasttransitorily) forms of compensation.

The Financialization of CEO Compensation: the Consequence of the Internal Restructuringof the Divisions of the Quoted CorporationThe transformation of the structure of CEO compensation suggests another interpretationderived from the history of the internal organization of large American corporation. In theearly days of the so-called American mass-production system stands the emblematic figureof an engineer who conceives new production methods and products: Henry Ford is a goodexample of such a view of the corporation. But the implementation of mass productiontriggered many problems with the work force (high turnover, strikes, absenteeism, poorproduct quality). Thus Personnel Management becomes an important division of the largecorporation. During the inter-war period, one of the issues was the discrepancy between theexplosion of mass production with a still limited market, due to an income distributiondistorted in favour of the wealthiest stratum of the population. Such an imbalance meantthat Marketing and Design became increasingly important corporate departments.

Fig. 13. From the transparent to the non apparent: the trickle down strategy of CEO about theircompensation.

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Together these elements helped to deliver the configuration of the American corporationthat emerged during the Golden Age of Sloanism.

But progressive financial liberalization triggered a series of innovations that calledfor the specialization of top management in financial asset management. Since the mid-1980s the chief financial officer (CFO) has become a central figure in the American cor-poration. Whereas the expertise of the engineer, like that of the production systemspecialist, was largely specific to a sector, a product, a method of production or a certaintype of equipment, financial management is much more homogeneous across corporations.Furthermore, in the era of global finance, the ability to generate financial profits by cleverportfolio management has contributed to the performance of corporations that used to befocused on manufacturing and marketing. Last, but not least, the rise of the CFO fits quitewell with the growing role of direct finance, since the CFO is in a good position to deal withinstitutional investors, analysts, trusts and pension funds and to convince them to buyshares in his/her company (Figure 14).

This shift in the distribution of power within quoted corporations may help explain atone and the same time the increasing share of stock options in the compensation of CEOs(Table 5) and the rapid increase in CEOs’ total compensation: has the financial sector beenthe promoter of higher compensation (see Table 3)? If one believes in the cyclical pattern ofmanagerial strategies and fads, the bursting of the Internet bubble and the rediscovery thatmature sectors can provide a significant and stable rate of return could imply a comebackfor the production manager, and by extension the R&D manager, as the key competitiveassets of the large corporation.

Fig. 14. The shift of internal control within the corporation: the rise of CFO as CEO.


The Power of Managers in the Political Arena

It is now time to look beyond the inner micro-structure and functioning of the large corpora-tion that give rise to the significant autonomy and power of top executives and explore howthe insertion of the large quoted corporation into the social and political system has changedsince the mid-1980s. The rise of CEO compensation and, in particular, the surge in stockoptions may find a series of relevant explanations at the macro-level.

Financial Liberalization has been a Prerequisite for the CEO Compensation ExplosionThe internal shift in the hierarchy of the departments of the large firm shown by Figure 16 isclosely related to the transformation in the American growth regime. Clearly, the explosionof CEO compensation and the rise of the CFOs could not have happened under the Fordistregime, since finance was strictly regulated and the major issue was about the mutual adjust-ment of production along with (largely domestic) demand, in accordance with the then over-whelming reference to the Keynesian style of monetary and budgetary policies. But the crisisof Fordism back in the late 1960s opens a period of major structural change, includingimport penetration, labour market deregulation, and financial innovation and liberaliza-tion. Wage earners’ bargaining power is therefore eroded and, correspondingly, managershave to respond more to the demands of financial markets and less to those of labour. Thereform of pensions plays a crucial role, since it links the evolution of the wage/labour nexuswith the transformation of the financial regime (Montagne 2003). On one hand, the influxof pension funds into the stock market increases its liquidity and thus makes the marketprone to financial bubbles. On the other, financial intermediaries and institutions putforward the idea that shareholder value should be the only concern of quoted corporations.The financialization and explosion of CEO compensation are the logical outcome of theinteraction of these two mechanisms (Figure 15).

When Economic Power is converted into Political PowerThis explanation in terms of political economy usefully complements a typicallymicro-grounded analysis of the power of managers within the corporation. It is aninvitation to explore how they convert their economic power into the ability partially toshape economic policy according to their interests. Over the last two decades, large corpora-tions have used both exit and voice in order to be influential in the political arena. First,

Fig. 15. The main episodes and factors in the financialisation of executive remuneration.

36 R. BOYER

with the great opening up of national economies and the free movement of capital, themanagers of multinational corporations have been able to redraw domestic labour contractsaccording to the requirements of the competitiveness of their domestic sites of production(see Figure 5). Second, they have sought lower taxation of profits, on the implication thatthey might otherwise take up the preferential treatment on offer abroad. Thus managershave been combining the threat of delocalization, i.e. exit, along with voice via lobbyingin the direction of lawmakers.

During the post-war Golden Age there was an implicit alliance between a fraction ofthe managers and wage earners, and this compromise was also embedded in the style ofeconomic policy: the search for full employment, the constitution of welfare, as well as highand redistributive taxation. Nowadays, implicitly or explicitly, governments are adoptingpro-business policies: deregulation of labour markets, slimming down of welfare benefits,lower taxation of high incomes, and an accommodating concept of fair competition. This isthe context that has encouraged the profound transformation in the economic and socialposition of top managers. The purpose of the next section is to offer some evidence inorder to sustain the hypothesis put forward by Figures 6 and 10: the transformation of coreeconomic institutions during the last two decades has consolidated and legitimized thepower of top managers at the society-wide level.

The General Context of Rising InequalityIn retrospect, it is clear that the period 1950–70 saw a quite unprecedented reduction ofinequality. The top decile’s income share (representing nearly 45 per cent in the 1930s) was

Fig. 16. The US: the top decile’s income share, 1917–1998.

Reproduced with permission of MIT Press.


drastically reduced to 32 per cent after the Second World War. This proportion rose slowlyfrom 1973 to 1987, before rising rapidly during the 1990s (Figure 16). This upward trendcoincided first with the stiffening of foreign competition and labour market deregulation(1973–87) and then with the evolution of the American economy towards a finance-ledregime (1988–97).

This rising inequality within households assumed a specific form in the United States,where the redistributive role of taxation (see Tables 6–7) and a limited universal welfarecould not counteract the trends generated by labour markets. For nearly three decades –more precisely, from 1971 to 1995 – the poorest 20 per cent of households experienced nearstagnation of their real income after taxation. By contrast, the most affluent householdsbecame still more affluent, especially after 1987 and after 1995 (Figure 17). These shiftscoincide with the dates of international pressure on American competitiveness (the mid-1980s) and the boom in financialization (1995).

The compensation of CEOs has been evolving within this general context. In theUnited States, over the last two decades, attitudes to the dividing line between legitimateand exorbitant inequality have been shifting. The question is then: how have capital andentrepreneurial incomes contributed to such a rise in the income of the richest 1 per cent ofthe population?

The Surge of Entrepreneurial Incomes contributes to the Growing Number of Super-richA recent study compares the distribution of total income between wages, capital income andentrepreneurial income among the wealthiest 10 per cent of the population at two periods, in

TABLE 6

Contrasted evolutions of US tax rates for middle-class and wealthy families

Year Effective federal tax rate

Median family Millionaire or top 1%

1948 5.30 76.91955 9.60 85.51960 12.35 66.91965 11.35 68.61970 16.061975 20.03 35.51977 31.71980 23.681981 25.091982 24.461983 23.761984 24.251985 24.44 24.91986 24.771987 23.211988 24.30 26.91989 24.37 26.71990 24.63

Source: Phillips (2002: 96).

38 R. BOYER

TABLE 7

The declining share of the US federal tax burden paid bycorporations and the rising share of payroll taxes

Year Share of total receipts (%)

Corporate taxes Payroll taxesa

1950 26.5 6.91960 23.2 11.81970 17.0 18.21980 12.5 24.51990 9.1 35.52000 10.2 31.1

Note:a Social security and MedicareSource: Phillips (2002: 149).

Fig. 17. The polarisation of America (1967–1997). Average inflation-adjusted annual after taxincome of poor, middle class, and rich households.

1998 and 1929 (Piketty & Saez 2003). Whereas in 1929 capital income represented 70 percent of the income of the wealthiest 1 per cent of households, in 1998 this source of incomerepresented only 10 per cent, since the largest proportion of income is related to wages.Nevertheless, a quite interesting feature is that the share of entrepreneurial income is


increasing steadily as we shift from the wealthiest 5 per cent to the wealthiest 1 per cent(Figure 18). Interestingly, the share of capital income is also increasing, but at most itrepresents 20 per cent of total income for the wealthiest 1 per cent. In comparison with theinter-war period, these data suggest two conclusions:

Fig. 18. The US: Income composition of top groups within the top deciles in 1929 and 1998.Reproduced with permission of MIT Press.

40 R. BOYER

1 First, the wealthiest part of the population nowadays belong to the elite of wage earnersand they combine the two other sources of income, which complement rather thansubstitute for wages.

2 Second, the fact that income of entrepreneurial origin is increasing among the toppercentiles faster than income derived from capital suggests that the power of managershas been more significant than the power of financiers.

Top Executives have Divorced from LabourMore direct evidence of the power of CEOs can be found in the same research (Figure 19).Back in the early 1970s, the average compensation of the top ten CEOs was around $1.3million (at 1999 prices), whereas the average salary was around $40,000. Since 1975 thetrends of these two variables have been diverging: over a quarter of a century there has beenquasi-stagnation of the average salary, while rapid and quasi-continuous increases in theaverage compensation of the top 100 CEOs allowed pay to reach the level of $40 million in1999. Again, an acceleration of CEO total compensation after 1995, i.e. the beginning of thefinancial bubble in the United States, can be noted.

These figures seem to confirm the core hypothesis of this article: benefiting from thecompetitive threat exerted by foreign competition, and even more so as a consequence ofcorporate governance of financialization, American CEOs no longer consider themselves asthe elite of the permanent wage earners. Nevertheless, in Gemany or Japan CEOs continueto see themselves as the upper stratum of wage earners. Not any more in the United States,where they are part of an implicit alliance with financiers.

Fig. 19. The US: CEO pay versus average wage, 1970–1999.

Reproduced with permission of MIT Press.


The Concentration of Wealth goes along with Stock Market BubblesIn historical retrospect, the surge of inequality in terms of income, and even more so wealth,is closely associated with the waves of financial speculation, at least in economies suchas that of the United States, where tax and welfare systems do not have significant redis-tributive effects (Figure 20). The previous developments suggest that top executives benefitmore than the typical rentier, even though finance seems to play the leading role in shapingthe objectives and organization of the corporate world. If financial markets constraincorporate strategies in the short run by their rapid changes in the value of stocks, in the longrun executives of service and manufacturing firms do control the sources of profit.

The Tax System is Redesigned in Favour of the WealthiestIn European countries, such a pattern is less marked and can be mitigated by intensiveredistribution via progressive income tax, heavy inheritance tax and of course the roleof universal welfare. Such is not the case in the United States, since rich individualsdo participate in political debates and polls. Consequently, they are more efficient at

Fig. 20. The US wealth inequality and stock market peaks.

42 R. BOYER

lobbying in order to deliver reductions in the high-bracket income marginal tax than theunderprivileged are at mobilizing in favour of redistributive measures.

Whereas the effective federal tax rate for the median American family has been nearlyconstant since 1980, after a significant increase since the 1960s, the shift has been in theopposite direction for millionaires and the top 1 per cent wealthiest households (Table 6).Similarly, corporate taxes have been declining to very modest levels (10 per cent), but pay-roll tax and welfare contributions are at 31 per cent in 2000, up from 6.9 per cent in 1950(Table 7). This is new evidence in favour of a political economy interpretation that links thepolitical and economic spheres.

Considering all the previous evidence, it becomes clear that the power of managers isnot restricted to the information and power asymmetry typical of any firm, and which isexacerbated in the large corporation. At the society-wide level, the rise of entrepreneurialincome, the evolution of the conception of social justice (market allocations are fair), therevision of income tax, and finally the reduction in the share of corporations in total taxreceipts confirm the hypothesis of a renewed political power on the part of large corporations,and especially of their top executives.

Conclusion: Managers, Financiers and Politicians

The main objective of this article has been to propose an explanation for one of thebiggest contemporary paradoxes, i.e. the explosion of CEOs’ compensation far ahead andfrequently quite independently of the actual performance of their corporations.

The Contemporary Situation in Historical PerspectiveThe issue of the control and reward of managers is an integral part of the wider questionabout the nature of corporate governance in a world of largely open national economiesand global finance. Contemporary concerns about the legitimacy and efficacy of stockoption grants as an incentive for controlling managers have their origins in the crisis of theSloanist corporation and the related domestic growth regime. The progressive opening-upto world competition, labour market deregulation and then financial deregulation, the riseof pension funds and the evolution of the bargaining power of unions have induced a dualshift. At the company level, restructuring has affected production organization but alsoshifted priorities to financial management. At the macroeconomic level, the previous modelbased on mass production and consumption has undergone a crisis, and after a long periodof trials and errors the engine of growth has been the outcome of the synergy betweenfinancial innovations and the creation and diffusion of information and communicationtechnologies.

The Plea for Stock Options has no Theoretical RationaleThe arguments that have been used to justify the introduction of preferred stocks or stockoptions have proven to be erroneous by contemporary theories as well as by many empiricalevidences. The interests of professional managers and owners can never be fully reconciled,and the diffusion of ownership makes the control of managers still more difficult. Inciden-tally, optimal contract theory would advise the use of indexed stock options, that would


reward only relative performance with respect to peers, filtering out the perverse effectsassociated with past dependence, lax monetary policy, macroeconomic and sectoral boomsand last but not least the macro-inefficiency of financial markets. The fact that only aminority of stock options are indexed means that they are not at all endorsed by contempo-rary micro-analyses of principal/agent literature and the theory of contracts. The idea thatstock options were the required complements to shareholder value and value creation hasbeen invalidated by the evolution of the rate of return on equity of large corporations duringthe 1990s. Almost no empirical study finds a positive correlation between option grants andthe economic performance of the firm. Repeated financial scandals have made clear thedifference in the interests of and the returns for top managers and the average stockholdersrespectively.

The Intrinsic Power of Managers at the Firm Level and its Extension at the Society-wideLevelThe observed asymmetry between top managers and stockholders finds its origins at thecore of the objective of the firm: how to generate profits? The old conventional neoclassicaltheory states that profit results from the optimal combination of totally substitutablefactors of production: labour, equipment and managerial talents, in response to theirmarket prices. On the contrary, modern theorizing on the firm stresses that a positivenet profit is the outcome of the combination of complementary assets and firm-specificcompetences: none of these factors can be bought or mimicked by the market, still less byfinancial markets. Who is in charge of generating these profits? Precisely, the top executives.The very reason that makes the firm efficient confers on CEOs and CFOs significanteconomic power. First, they have access to the relevant and private information that has notnecessarily to be made public (for instance, about the real sources – and even the amount –of profit generated by the firm). Second, they have a better knowledge than shareholders,analysts or fund managers of the strengths and weaknesses of the firm, since they know theroutines and the synergies that make the firm profitable. (Outsiders are best equipped toanalyse the impact of macroeconomic/sectoral variables upon the evolution of the profit,not its internal determinants.) Third, CEOs and directors have the power to make decisionsabout the strategy as well as the day-to-day management of the firm. (Shareholders haveonly ex post control, mainly by exit, i.e. selling their shares, and annually they have a chanceto voice their opinion and cast their vote on an agenda set by the corporation.) Managers’control over their remuneration largely results from this intrinsic asymmetry. In the era offinancialization this superiority took the form of remuneration by stock options. In the pastit had another form (salaries, bonuses), and in the future it will evolve toward new forms.

In the 1990s, in defence of shareholders, managers have converted this internalpower into financial wealth, thus benefiting from the liquidity and the speculative bubbleassociated with the Internet. Given the long-lasting erosion of wage earners’ bargainingpower and the shift of governments towards a pro-business stance, the business communityhas lobbied for reform of labour laws and the welfare and the tax systems. In a sense, theeconomic power of managers has been extended to include a significant dose of politicalpower. For instance, the fact that stock options enjoyed privileged taxation status, and werenot regarded as a cost to be taken into account in the evaluation of profits, created avirtuous circle of seemingly impressive company performance and the rise of stock marketvaluations.

44 R. BOYER

This is why the optimal contract approach to the control and rewarding of managers isbound to fail, given the intrinsic power of top managers, the origin of which is related to thevery sources of profit in contemporary capitalism. By contrast, combining a managerialpower approach with a typical political economy analysis conveys a simple and rather con-vincing interpretation of the paradox under review. Under the motto of shareholder value,managers implicitly allied with financiers in order to extend their power and remuneration.

The Search for a New Form of Corporation?The limits of the current organization of quoted corporations have become clear since theearly 2000s, and almost all countries are trying to cope with the issue of managerial control.This article has argued that there is no panacea but it has pointed to two possible items onthe agenda of corporate reform. First, any move from a purely shareholder vision towards astakeholder conception of the corporation would reduce the probability of managerial greedand erroneous strategic decisions. Second, no contract is self-enforcing and therefore someother form of public control of the accounting practices of quoted corporations is required inorder to prevent an alliance between CEOs and auditors, at the expense of rank-and-fileshareholders. Lastly, some macroeconomic contexts are more likely to generate speculativebubbles and allow excessive power to CEOs: when inflation and consequently interest ratesare low, de facto the central bankers may be at the origin of financial speculation, and indi-rectly trigger quite detrimental strategies on the part of top executives. During the 1980s inJapan and subsequently during the 1990s in the US, monetary policy has been at the heart oferroneous business strategies and unjustified wealth from CEOs. All policy makers shouldlearn from this episode.

Acknowledgement

This article develops the ideas presented at the conference on ‘Controlling and RewardingManagers’ held at the University of Manchester, 14 May 2004.

Note

1 For instance, Chauvin and Shenoy (2001) show that on average stock prices usually decrease priorto executive stock options grants.

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46 R. BOYER

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From shareholder value to CEO power: The paradox of the 1990s

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